Income of partners for performing investment management services treated as ordinary income received for performance of services

(a)

In general

Part I of subchapter K of chapter 1 of the Internal Revenue Code of 1986 is amended by adding at the end the following new section:

710.

Special rules for partners providing investment management services to partnership

(a)

Treatment of distributive share of partnership items

For purposes of this title, in the case of an investment services partnership interest— (1)

In general

Notwithstanding section 702(b)— (A)any net income with respect to such interest for any partnership taxable year shall be treated as ordinary income, and (B)any net loss with respect to such interest for such year, to the extent not disallowed under paragraph (2) for such year, shall be treated as an ordinary loss.

All items of income, gain, deduction, and loss which are taken into account in computing net income or net loss shall be treated as ordinary income or ordinary loss (as the case may be).

(2)

Treatment of losses

(A)

Limitation

Any net loss with respect to such interest shall be allowed for any partnership taxable year only to the extent that such loss does not exceed the excess (if any) of— (i)the aggregate net income with respect to such interest for all prior partnership taxable years, over (ii)the aggregate net loss with respect to such interest not disallowed under this subparagraph for all prior partnership taxable years. (B)

Carryforward

Any net loss for any partnership taxable year which is not allowed by reason of subparagraph (A) shall be treated as an item of loss with respect to such partnership interest for the succeeding partnership taxable year. (C)

Basis adjustment

No adjustment to the basis of a partnership interest shall be made on account of any net loss which is not allowed by reason of subparagraph (A). (D)

Prior partnership years

Any reference in this paragraph to prior partnership taxable years shall only include prior partnership taxable years to which this section applies. (3)

Net income and loss

For purposes of this section— (A)

Net income

The term net income means, with respect to any investment services partnership interest for any partnership taxable year, the excess (if any) of— (i)all items of income and gain taken into account by the holder of such interest under section 702 with respect to such interest for such year, over (ii)all items of deduction and loss so taken into account. (B)

Net loss

The term net loss means, with respect to such interest for such year, the excess (if any) of the amount described in subparagraph (A)(ii) over the amount described in subparagraph (A)(i). (b)

Dispositions of partnership interests

(1)

Gain

Any gain on the disposition of an investment services partnership interest shall be treated as ordinary income and shall be recognized notwithstanding any other provision of this subtitle. (2)

Loss

Any loss on the disposition of an investment services partnership interest shall be treated as an ordinary loss to the extent of the excess (if any) of— (A)the aggregate net income with respect to such interest for all partnership taxable years, over (B)the aggregate net loss with respect to such interest allowed under subsection (a)(2) for all partnership taxable years. (3)

Disposition of portion of interest

In the case of any disposition of an investment services partnership interest, the amount of net loss which otherwise would have (but for subsection (a)(2)(C)) applied to reduce the basis of such interest shall be disregarded for purposes of this section for all succeeding partnership taxable years. (4)

Distributions of partnership property

In the case of any distribution of property by a partnership with respect to any investment services partnership interest held by a partner— (A)the excess (if any) of— (i)the fair market value of such property at the time of such distribution, over (ii)the adjusted basis of such property in the hands of the partnership,

shall be taken into account as an increase in such partner’s distributive share of the taxable income of the partnership (except to the extent such excess is otherwise taken into account in determining the taxable income of the partnership),

(B)such property shall be treated for purposes of subpart B of part II as money distributed to such partner in an amount equal to such fair market value, and (C)the basis of such property in the hands of such partner shall be such fair market value.

Subsection (b) of section 734 shall be applied without regard to the preceding sentence.

(5)

Application of section 751

In applying section 751(a), an investment services partnership interest shall be treated as an inventory item. (c)

Investment services partnership interest

For purposes of this section— (1)

In general

The term investment services partnership interest means any interest in a partnership which is held by any person if it was reasonably expected (at the time that such person acquired such interest) that such person (or any person related to such person) would provide (directly or indirectly) a substantial quantity of any of the following services: (A)Advising as to the advisability of investing in, purchasing, or selling any specified asset. (B)Managing, acquiring, or disposing of any specified asset. (C)Arranging financing with respect to acquiring specified assets. (D)Any activity in support of any service described in subparagraphs (A) through (C).

For purposes of this paragraph, the term specified asset means securities (as defined in section 475(c)(2) without regard to the last sentence thereof), real estate held for rental or investment, interests in partnerships, commodities (as defined in section 475(e)(2)), or options or derivative contracts with respect to any of the foregoing.

(2)

Exception for certain capital interests

(A)

In general

In the case of any portion of an investment services partnership interest which is a qualified capital interest, all items of income, gain, loss, and deduction which are allocated to such qualified capital interest shall not be taken into account under subsection (a) if— (i)allocations of items are made by the partnership to such qualified capital interest in the same manner as such allocations are made to other qualified capital interests held by partners who do not provide any services described in paragraph (1) and who are not related to the partner holding the qualified capital interest, and (ii)the allocations made to such other interests are significant compared to the allocations made to such qualified capital interest. (B)

Special rule for dispositions

In the case of any investment services partnership interest any portion of which is a qualified capital interest, subsection (b) shall not apply to so much of any gain or loss as bears the same proportion to the entire amount of such gain or loss as— (i)the distributive share of gain or loss that would have been allocable to the qualified capital interest under subparagraph (A) if the partnership sold all of its assets immediately before the disposition, bears to (ii)the distributive share of gain or loss that would have been so allocable to the investment services partnership interest of which such qualified capital interest is a part. (C)

Qualified capital interest

For purposes of this paragraph, the term qualified capital interest means so much of a partner’s interest in the capital of the partnership as is attributable to— (i)the fair market value of any money or other property contributed to the partnership in exchange for such interest, (ii)any amounts which have been included in gross income under section 83 with respect to the transfer of such interest, and (iii)the excess (if any) of— (I)any items of income and gain taken into account under section 702 with respect to such interest for taxable years to which this section applies, over (II)any items of deduction and loss so taken into account.

The qualified capital interest shall be reduced by distributions from the partnership to the partner and by the excess (if any) of the amount described in clause (iii)(II) over the amount described in clause (iii)(I).

(D)

Treatment of certain loans

(i)

Proceeds of partnership loans not treated as qualified capital interest of service providing partners

For purposes of this paragraph, an investment services partnership interest shall not be treated as a qualified capital interest to the extent that such interest is acquired in connection with the proceeds of any loan or other advance made or guaranteed, directly or indirectly, by any partner or the partnership (or any person related to any such partner or the partnership). (ii)

Reduction in allocations to qualified capital interests for loans from nonservice providing partners to the partnership

For purposes of this paragraph, any loan or other advance to the partnership made or guaranteed, directly or indirectly, by a partner not providing services described in paragraph (1) to the partnership (or any person related to such partner) shall be taken into account as invested capital of such partner. (3)

Related persons

A person shall be treated as related to another person if the relationship between such persons would result in a disallowance of losses under section 267 or 707(b). (d)

Other income and gain in connection with investment management services

(1)

In general

If— (A)a person performs (directly or indirectly) investment management services for any entity, (B)such person holds a disqualified interest with respect to such entity, and (C)the value of such interest (or payments thereunder) is substantially related to the amount of income or gain (whether or not realized) from the assets with respect to which the investment management services are performed,

any income or gain with respect to such interest shall be treated as ordinary income. Rules similar to the rules of subsection (c)(2) shall apply where such interest was acquired on account of invested capital in such entity.

(2)

Definitions

For purposes of this subsection— (A)

Disqualified interest

(i)

In general

The term disqualified interest means, with respect to any entity— (I)any interest in such entity other than indebtedness, (II)convertible or contingent debt of such entity, (III)any option or other right to acquire property described in subclause (I) or (II), and (IV)any derivative instrument entered into (directly or indirectly) with such entity or any investor in such entity. (ii)

Exceptions

Such term shall not include— (I)a partnership interest, (II)stock in a taxable corporation, and (III)except as provided by the Secretary, stock in an S corporation. (B)

Taxable corporation

The term taxable corporation means— (i)a domestic C corporation, or (ii)a foreign corporation substantially all of the income of which is— (I)effectively connected with the conduct of a trade or business in the United States, or (II)subject to a comprehensive foreign income tax (as defined in section 457A(d)(2)). (C)

Investment management services

The term investment management services means a substantial quantity of any of the services described in subsection (c)(1). (e)

Regulations

The Secretary shall prescribe such regulations as are necessary or appropriate to carry out the purposes of this section, including regulations to— (1)provide modifications to the application of this section (including treating related persons as not related to one another) to the extent such modification is consistent with the purposes of this section, (2)prevent the avoidance of the purposes of this section, and (3)coordinate this section with the other provisions of this title. (f)

Cross reference

For 40 percent no fault penalty on certain underpayments due to the avoidance of this section, see section 6662.

(b)

Income from investment services partnership interests not treated as qualifying income of publicly traded partnerships

Subsection (d) of section 7704 of such Code is amended by adding at the end the following new paragraph:

(6)

Income from investment services partnership interests not qualified

(A)

In general

Items of income and gain shall not be treated as qualifying income if such items are treated as ordinary income by reason of the application of section 710 (relating to special rules for partners providing investment management services to partnership). (B)

Special rules for certain partnerships

(i)

Certain partnerships owned by real estate investment trusts

Subparagraph (A) shall not apply in the case of a partnership which meets each of the following requirements: (I)Such partnership is treated as publicly traded under this section solely by reason of interests in such partnership being convertible into interests in a real estate investment trust which is publicly traded. (II)50 percent or more of the capital and profits interests of such partnership are owned, directly or indirectly, at all times during the taxable year by such real estate investment trust (determined with the application of section 267(c)). (III)Such partnership meets the requirements of paragraphs (2), (3), and (4) of section 856(c). (ii)

Certain partnerships owning other publicly traded partnerships

Subparagraph (A) shall not apply in the case of a partnership which meets each of the following requirements: (I)Substantially all of the assets of such partnership consist of interests in one or more other partnerships which are traded on an established securities market. (II)Substantially all of the income of such partnership is ordinary income or section 1231 gain (as defined in section 1231(a)(3)). (C)

Transitional rule

In the case of a partnership in existence on the date of the enactment of this paragraph, subparagraph (A) shall not apply to any taxable year of the partnership beginning before the date which is 10 years after the date of the enactment of this paragraph.

(c)

Imposition of penalty on underpayments

(1)

In general

Subsection (b) of section 6662 of such Code is amended by inserting after paragraph (5) the following new paragraph:

(6)The application of subsection (d) of section 710 or the regulations prescribed under section 710(e) to prevent the avoidance of the purposes of section 710.

(2)

Amount of penalty

(A)

In general

Section 6662 of such Code is amended by adding at the end the following new subsection:

(i)

Increase in penalty in case of property transferred for investment management services

In the case of any portion of an underpayment to which this section applies by reason of subsection (b)(6), subsection (a) shall be applied with respect to such portion by substituting 40 percent for 20 percent.

(B)

Conforming amendments

Subparagraph (B) of section 6662A(e)(2) of such Code is amended— (i)by striking section 6662(h) and inserting subsection (h) or (i) of section 6662, and (ii)by striking

gross valuation misstatement penalty

in the heading and inserting

certain increased underpayment penalties

. (3)

Reasonable cause exception not applicable

Subsection (c) of section 6664 of such Code is amended— (A)by redesignating paragraphs (2) and (3) as paragraphs (3) and (4), respectively, (B)by striking paragraph (2) in paragraph (4), as so redesignated, and inserting paragraph (3), and (C)by inserting after paragraph (1) the following new paragraph:

(2)

Exception

Paragraph (1) shall not apply to any portion of an underpayment to which this section applies by reason of subsection (b)(6).

(d)

Income and loss from investment services partnership interests taken into account in determining net earning from self-employment

(1)

Internal Revenue Code

Section 1402(a) of such Code is amended by striking and at the end of paragraph (16), by striking the period at the end of paragraph (17) and inserting ; and, and by inserting after paragraph (17) the following new paragraph:

(18)notwithstanding the preceding provisions of this subsection, any amount treated as ordinary income or ordinary loss of any individual under section 710 shall be taken into account in determining the net earnings from self-employment of such individual.

(2)

Social Security Act

Section 211(a) of the Social Security Act is amended by inserting after paragraph (16) the following new paragraph:

(17)Notwithstanding the preceding provisions of this subsection, any amount treated as ordinary income or ordinary loss of any individual under section 710 of the Internal Revenue Code of 1986 shall be taken into account in determining the net earnings from self-employment of such individual.

(e)

Conforming amendments

(1)Subsection (d) of section 731 of the Internal Revenue Code of 1986 is amended by inserting section 710(b)(4) (relating to distributions of partnership property), after to the extent otherwise provided by. (2)Section 741 of such Code is amended by inserting or section 710 (relating to special rules for partners providing investment management services to partnership) before the period at the end. (3)The table of sections for part I of subchapter K of chapter 1 of such Code is amended by adding at the end the following new item:

Sec. 710. Special rules for partners providing investment management services to partnership.

(f)

Effective date

(1)

In general

Except as otherwise provided in this subsection, the amendments made by this section shall apply to taxable years ending after ___. (2)

Partnership taxable years which include effective date

In applying section 710(a) of the Internal Revenue Code of 1986 (as added by this section) in the case of any partnership taxable year which includes ___, the amount of the net income referred to in such section shall be treated as being the lesser of the net income for the entire partnership taxable year or the net income determined by only taking into account items attributable to the portion of the partnership taxable year which is after such date. (3)

Dispositions of partnership interests

Section 710(b) of the Internal Revenue Code of 1986 (as added by this section) shall apply to dispositions and distributions after ___. (4)

Other income and gain in connection with investment management services

Section 710(d) of such Code (as added by this section) shall take effect on ___. (5)

Publicly traded partnerships

The amendment made by subsection (b) shall apply to taxable years beginning after ___.